Letters of Intent and limits of liability
AMPLEFORTH v TURNER & TOWNSEND [2012]
This case covered issues such as the appropriate use of Letters of Intent where projects have to be started early before formal contracts have been concluded and the enforceability of limitations of liability. It highlighted that often the existence of insurance coverage is a key factor in determining the reasonableness of limitations upon liability. It also demonstrated that project managers and consultants (including solicitors!) may find themselves in the firing line if they fail to diligently check that adequate steps are taken to ensure that a contract being negotiated is finally signed.
Facts:
- A commissioned building works for its school from K and employed T&T as project managers. The dispute arose out of the third of three separate projects to build additional residential accommodation at the school. There were no problems with the first two projects but the third one was delivered late.
- K undertook work in relation to the third project under a series of ‘letters of intent’ (LOIs) issued from time to time. A more formal contract, despite having been under discussion from the outset, was only ever signed after the work had been completed and the parties had reached a settlement as to their various claims for damages/additional payments following a mediation. As is not uncommon in projects, there was a great deal of urgency for K to start work and it seems it was felt that a LOI was the best and quickest way to achieve that.
- At the time of the first LOI the parties had not reached agreement on the level of any liquidated damages (LDs) for delay but after several months this had apparently been agreed. None of the LOIs issued ever mentioned LDs.
- Following resolution of the dispute with K, A brought a claim against T&T alleging that had they exercised reasonable skill it would have procured K’s signature to a formal contract at an earlier stage and this would have put it in an improved position in the dispute.
Decision:
- T&T were held to be in breach of their duty to exercise reasonable care.
- The Court found:
- Efforts to finalise contractual arrangements are of central, fundamental importance and by failing to take reasonable steps to finalise the contract, T&T had been negligent. LOIs were described as “contracts of a skeletal nature’” (a ‘necessary evil’) and do not protect the parties in the same manner as a formal contract would.
- It is extremely unusual for a project to be undertaken from beginning to end only under a series of LOIs and this, according to the Judge, indicated that something had gone wrong (although not necessarily because of either party’s fault).
- T&T failed:
- to adequately focus on the matters that were preventing a formal contract being signed;
- to identify and document each issue in an action list and work urgently to resolve each one by one (there was no ‘structure’ to the approach);
- to bring proper pressure to bear on K, including by letting it be known that no further LOIs would be forthcoming after the third.
- T&T had not advised A of the need to obtain signature of the contract and of the benefits of getting the formal contract executed. At the outset A had been adequately advised regarding the ‘classic’ use of LOIs, namely to permit the works to commence at a time when the details of the contract had not been worked out. However, at some subsequent point the Court felt that advice should have been given that the passage of time meant that it was no longer appropriate to continue issuing LOIs and that a formal contract should have been insisted upon.
- T&T had also not appreciated that work done under the LOIs was not subject to the provisions of the as yet unsigned formal contract despite the fact that the LOIs specifically provided that “Neither of us will be bound by the intended [formal] contract unless and until the written document is executed by each of us”. T&T appeared to find the issuing of further LOIs an acceptable route forward and efforts at resolution of outstanding contractual issues lacked focus and any sense of necessity.
- Once a project starts under an LOI, any attempt to insist on a formal contract carries with it the potential that at some point an impasse may be reached and the contractor’s ‘bluff’ might have to be called. The Judge clearly did not see that there was a significant risk that in the absence of further LOIs, K would down tools and walk away even though K had twice threatened to withdraw its labour.
- K was willing to sign the formal contract once the identified issues had been resolved. It had no undeclared unwillingness to sign the formal contract even once it had become apparent that there was a possibility of some delay to the project and therefore that the LDs provisions of the formal contract might bite. Had T&T acted with reasonable care and skill there was, according to the Judge, a two-thirds chance of K signing the proper contract in the form which included the LDs provision.
- The £50,000 in LDs per week of delay was not regarded by the Court as likely to constitute a penalty (which would render it unenforceable). In this respect it was helpful that A had gone through some financial analysis of its potential loss when coming up with the figure. Although the figure was high, its primary aim was seen as being compensatory rather than a deterrent.
- It will be fairly exceptional, where the parties are in the equivalent of a ‘subject to contract’ type situation, for the Court to find that an implied contract has arisen based on the agreed elements of the draft formal contract under discussion between the parties (as happened in RTS v Müller [2009]. In that case the original LOI had expired whereas here the LOIs were continually extended).
Points to Note:
- Although the Judge clearly felt that the formal contract was a significant benefit to A and an objective to be eagerly pursued, this will not in our view always be the case. Particularly if the other contracting party is being inflexible and unreasonable on key points, a party may be better off even in the long term under a combination of a LOI and the provisions implied at common law. Here, for example, the LOI contained no limitation of liability in favour of K leading to potentially uncapped liability.
- LOIs do play a useful part in the contracting process on a fairly regular, probably too regular, basis. In our view the Judge underplayed the difficulties which can occur in concluding contractual negotiations especially once the project has started and the immediate urgency has been removed. The adverse impact on a party’s bargaining position once a project has started under a LOI should not be underestimated and the effect that developments in the project can play in making a contracting party less likely to sign up to the formal contract. In this case it was suggested that once delays in the project had become apparent, K might have been less likely to have signed the formal agreement complete with its LDs provisions but the Judge appeared to think that had limited or no effect.
- Although the Judge seemed pretty clear that the LOIs governed to the exclusion of the as yet unsigned formal draft contract, analysing which contract terms apply once a project has started without a property executed document is extremely difficult. Each of the High Court, the Court of Appeal and the Supreme Court came to different conclusions in the RTS v Müller case and over the course of three legal opinions in this case, the lawyers changed their minds completely. At first they said that the LD provisions agreed in principle would be likely to apply and ultimately they said that they certainly would not. The reality is that proceeding with projects on the basis of a LOI can lead to considerable potential uncertainty. A well drafted LOI can reduce that uncertainty to a degree but it is always best to try to reach agreement on outstanding points promptly.
- It was argued that since the individuals involved at T&T were not lawyers they should not be held to the same legal standards as lawyers. The Court disagreed. Since T&T had put together the LOIs and the more formal contract, if it was not competent, even with the assistance of its in-house lawyers, it should have advised A to obtain professional legal advice. What it could not do was proceed on the basis of a particular legal understanding and then say that they were not lawyers and could not be expected to bring a lawyer's understanding to bear. If in doubt, it would have been sensible to emphasise to A that it should take specialist legal advice.
- The very real risk that a party might walk away or suspend work if it feels that it does not have the benefit of a signed contract or LOI should also not be taken lightly. Whilst the likelihood may be quite small in most cases, it has to be borne in mind that on some occasions a contracting party might be looking for an escape route. The degree of risk is also a factor of two things – the likelihood that something will happen and the consequences should that event happen. In this case although the risk that K might have walked away may have been quite small, the consequences for A of K stopping work mid-way through the project would have been very considerable.
- Those advising clients on the pros and cons of LOIs really need to do so at the outset before any LOI is signed. In this case the Judge felt that at some point during the project T&T should have alerted A to the disadvantages of continuing to issue new, extended LOIs but in our view that is too late since by that point the parties have gone down a particular road with no opportunity to change course.
In relation to the limitation of liability point:
- T&T had been appointed for the first two projects under a Memorandum of Agreement. For the third project A had asked for a fee proposal. When supplied, this was accompanied by new ‘Terms of Appointment’ which contained a detailed limitation of liability provision. It is not entirely clear from the case report whether this was different from the limits which applied to the first two projects but the suggestion seems to be that it was. What is clear is that T&T made no attempt to do anything to bring the limitation (or the change) to A’s attention other than by supplying the copy as part of their proposal. A neither read nor signed the Terms but nevertheless they were held to be incorporated into the contract between the parties. This demonstrates that as between businesses, there is a considerable onus on customers to appreciate the terms upon which a proposal is being submitted.
- The Court then had to consider whether the limitation was reasonable under UCTA. The limitation was drafted in somewhat strange terms as follows: “Liability … shall be limited to such liability as is covered by Our Professional Indemnity Insurance Policy terms. … and in no event shall Our liability exceed the fees paid to Us or £1million whichever is the less."
- Another clause expressly stated: "We shall take out a policy of Professional Indemnity Insurance with a limit of indemnity of £10 million for any one occurrence or series of occurrences arising out of any one event.”
- These provisions therefore somewhat confusingly referenced three different figures, £10million, £1million and the total amount paid to T&T which was, in the event, £111,321. It was the latter which actually provided the limit. The reference to the £10million insurance cover was effectively completely redundant except perhaps to demonstrate that there would be some asset against which any claim could be enforced. However, the reference turned out to be costly for T&T.
- The Court held that the limitation was unreasonable, the primary justification being the existence of the insurance at the £10million level. However, the Judge seemed to have completely misunderstood the nature of insurance. He said: “The contract imposed on T&T an obligation to take out professional indemnity insurance to a level of £10 million. The cost of such insurance would, as a matter of commercial reality, be passed on to [A] within the fees payable. Yet the limitation clause would result in a limit of liability equal to the fees paid. The effect of upholding the limitation clause would be that, although the parties had contracted for the insurance of the risks and (implicitly) for A to pay for that insurance, by far the greater part of that insurance would be rendered illusory.”
- These comments appear to ignore the fact that the PI insurance would have been put in place at a corporate, possibly group level, and were not specific to this deal. The £10million of cover would apply for the benefit of T&T clients generally and in the light of other projects may have been more appropriate/necessary. Whilst the costs of the PI premium will have contributed to T&T’s overheads and will therefore have been borne in some small part by A, it is clearly incorrect to view A alone as having paid for £10million worth of insurance.
- Following this argument to its logical conclusion, if T&T had only undertaken to put in place a lower level of PI cover or even no cover at all, it would seemingly have had a much better chance of arguing that its limitation was reasonable and therefore enforceable even though there is no likelihood this would have affected the price charged to A to any degree or at all. It is very often the case that companies put in place insurance coverage at much higher levels than their contractual limitations, not least to protect against the risk that a particular limitation might be unenforceable. It seems wrong in principle that companies are at greater risk of their limitations being challenged just because they have been more prudent in putting in place higher levels of insurance.
- Previously decided cases (notably Shepherd Homes v Encia [2007]) made clear that just because a party has insurance at a particular level does not mean that it has to make the whole of that insurance available to its customers. Indeed, insurance companies supposedly take into account standard limitations in establishing premiums and all insurance policies typically require the insured to take reasonable steps to minimise their liability within their contractual terms so far as they reasonably can.
- It was unfortunate that the insurance undertaking was mixed up with the drafting of the limitation of liability clause. Such drafting should be avoided since it creates the wrong impression. T&T certainly did not help themselves in that respect.
- This decision has echoes of the ICL v St Albans judgment from as long ago as 1995, when the fact that ICL had ‘product liability’ insurance of £50million seemed to be the decisive factor in a High Court Judge coming to the conclusion that ICL’s standard limitation of liability was unreasonable. It had been thought that the legal world had moved on some distance in the past 17 years but, at least as far as understanding of insurance is concerned, perhaps not!